Fiscal Outlook: Federal Fiscal Outlook

GAO's federal budget simulations provide a broad context for considering policy options. An understanding of fiscal exposures—programs that may expose the government to future spending—can also inform these considerations.

Since 1992, GAO has published long-term fiscal simulations showing federal deficits and debt under different sets of policy assumptions. While the timing and pace of growth varies depending on the assumptions used, GAO's simulations illustrate that:

a fundamental imbalance between revenue and spending over the long term leads to continuous growth in debt as a share of gross domestic product (GDP), which is unsustainable;

increases in spending are largely driven by an aging population and rising health care costs; and

the growing gap between revenue and spending will further limit the federal government's flexibility to address future challenges.

For detailed information on GAO's most recent simulations see also this presentation.

Since the amount of spending in GAO's simulations depends largely on what is assumed about growth in spending for large entitlement programs, GAO shows the Baseline Extended simulation using both the Social Security and Medicare Trustees’ (Trustees) and Congressional Budget Office's (CBO) estimates for long-term spending on Social Security and major health entitlement programs (Medicare, Medicaid, and others). GAO also shows the Alternative simulation using different assumptions about health care cost growth based on CBO and Centers for Medicare & Medicaid Services Office of the Actuary (CMS Actuary) alternative projections. As the figure below shows, the results are largely the same. The outlook under either set of assumptions is unsustainable.

Source: GAO.
Note: Data are from GAO's Spring 2015 simulations. See the Assumptions & Data tab for a description of the revenue, spending, and other assumptions underlying these simulations.
Data: txt | pdf

Key Drivers of Long-Term Spending Pressures

In both simulations, spending for the major health and retirement programs will increase as a share of GDP in coming decades. Beyond the expansion in coverage under Medicaid and health care insurance exchange subsidies, over the first few decades, this spending is driven largely by the aging of the population. The oldest members of the baby-boom generation are already eligible for both Social Security retirement benefits and Medicare. As shown in the figure below, the number of baby boomers turning 65 jumped from an average of about 7,300 per day in 2011 to almost 10,000 per day in 2012 and is projected to continue to grow in coming years, reaching 11,000 per day in 2029. As a result, the share of the population older than 65 is projected to increase from roughly 13 percent to almost 20 percent during this time.

The longer-term outlook depends more heavily on assumptions about growth in health care spending for each beneficiary. One way of measuring growth in health care spending per beneficiary is the rate of excess health care cost growth. Generally speaking, excess cost growth is the extent to which the growth in health care spending per person exceeds the growth rate of GDP per person. Excess cost growth leads to an ever-growing share of the nation's income being spent on health care. Based on CBO’s 2014Long-Term Budget Outlook, excess cost growth averaged around 2 percent from 1975 to 2012 (the most recent year for which data are available). Going forward the Medicare Trustees and CBO assume that excess cost growth will slow because of the financial pressure health care spending is putting on the federal government, states, businesses, and households. How and when this transition takes place, however, is highly uncertain. According to CBO, health care cost growth has slowed in recent years, with health care spending remaining largely stable form 2009 to 2012. However, it remains unclear whether this represents a temporary event related to the recent recession, a one-time shift reflecting structural changes in how care is delivered or in payment mechanisms, or a longer-term change to the U.S. health care system resulting from increased efficiency and coordination.

Limited Budgetary Flexibility to Address Other Future Challenges

Growth in debt as a share of GDP and the resulting growth in net interest costs in GAO's simulations will limit the government's flexibility to address emerging budget issues and as-yet unforeseen challenges, such as another economic downturn or a large-scale natural disaster. In addition, GAO has identified a variety of other fiscal exposures—responsibilities, programs, and activities that may legally commit or create the expectation for future federal spending. Over the past decade, some fiscal exposures have grown due to events and trends and the government’s response to them. Increased attention to these fiscal exposures will be important for understanding risks to the federal fiscal outlook and enhancing oversight over federal resources.

Baseline Extended Simulation vs. Alternative Simulation

The Baseline Extended simulation generally assumes current laws continue into the future, including the discretionary spending limits and other spending reductions established by the Budget Control Act of 2011 (BCA) and revised by subsequent legislation. The Alternative simulation illustrates what happens if historical trends continue. The simulations also illustrate two potential paths for future health care cost growth. In the Baseline Extended simulation, the cost-containment mechanisms enacted in the Patient Protection and Affordable Care Act are assumed to be fully implemented and effective, slowing growth of health care spending over the long term. However, the Medicare Trustees, Congressional Budget Office (CBO), and the Centers for Medicare & Medicaid Services Office of the Actuary (CMS Actuary) have questioned whether certain cost-containment mechanisms can be sustained over the long term. This is reflected in the Alternative simulation in which policies that would restrain spending growth are phased out over time.

Both simulations show spending on interest, Social Security, and the major health programs absorbing increasing shares of revenue. When "all other spending"—or spending on such categories as national defense, homeland security, veterans' health care, mass transit, education, and basic research for future economic growth—is included, deficits reach more than 9 percent of GDP in 2030 in GAO’s Alternative simulation.

Net Interest

Social Security

Medicare & Medicaid, CHIP, and exchange subsidies

All other spending

Revenue

Source: GAO.
Note: Data are from GAO's Spring 2015 simulation based on the Trustees' intermediate
assumptions for Social Security and current law assumptions for Medicare.
Baseline Extended Simulation data: txtpdf

Net Interest

Social Security

Medicare & Medicaid, CHIP, and exchange subsidies

All other spending

Revenue

Source: GAO.
Note: Data are from GAO's Spring 2015 simulation based on the Trustees' intermediate
assumptions for Social Security and the CMS Actuary’s illustrative alternative assumptions for Medicare.
Alternative Simulation data: txtpdf

Closing the Fiscal Gap

Significant action to change the long-term fiscal path must be taken soon to minimize the disruption to individuals and the economy. The entire range of federal activities and spending—entitlement programs, other mandatory spending, discretionary spending, and revenue—will need to be reexamined. As we move forward, the federal government will need to make tough choices in setting priorities and ensuring that spending leads to positive results.

The fiscal gap represents the difference, or gap, between revenue and noninterest spending over a certain period, such as 75 years, that would need to be closed in order to keep debt held by the public at the end of the period from exceeding today’s level. The 75-year fiscal gap under GAO’s Baseline Extended simulation is 3.6 percent of GDP. The 75-year fiscal gap in GAO’s Alternative simulation is 6.7 percent of GDP. Closing the gap requires tax increases, spending reductions, or, more likely, a combination of the two. For example, to close the fiscal gap under GAO’s Baseline Extended simulation, either revenue would have to be almost 20 percent higher, or noninterest spending would have to be about 17 percent lower (or some combination of the two) on average each year over the 75-year period to keep debt held by the public as a share of GDP in 2089 from exceeding the level at the beginning of 2015. To close the fiscal gap under GAO’s Alternative simulation, either revenue would have to be 37 percent higher, or noninterest spending would have to be about 27 percent lower (or some combination of the two) on average each year over the same period. Even more significant changes would be needed to reduce debt to lower levels.

Further, delaying action increases the size of actions needed and the risk that the eventual changes will be disruptive and destabilizing to the economy and individuals. If no actions were taken for the next decade, revenue would have to be 43 percent higher, or noninterest spending would have to be about 31 percent lower (or some combination of the two) on average each year over the remaining 65-year period under the Alternative simulation to bring debt held by the public back to its 2015 level by 2089.

Solely through revenue increases

Solely through spending cuts

Source: GAO.
Note: Data are from GAO's Spring 2015 simulation based on the Trustees' intermediate
assumptions for Social Security and current law assumptions for Medicare.
Baseline Extended Simulation data: txtpdf

Solely through revenue increases

Solely through spending cuts

Source:GAO.
Note: Data are from GAO's Spring 2015 simulation based on the Trustees'
intermediate assumptions for Social Security and the CMS Actuary’s
illustrative alternative assumptions for Medicare.
Alternative Simulation data: txtpdf

A simulation is a hypothetical—a "what if?" GAO runs two simulations of the federal budget that illustrate the potential implications of different policy choices. Each simulation represents a bundle of budgetary and policy assumptions carried far out into the future. These assumptions, as well as how changes to key assumptions would affect GAO’s simulations, are described in more detail below. The simulations are not intended as predictions about the future. Rather, they can facilitate comparisons of the potential long-term budgetary consequences of alternative fiscal policy paths.

Uncertainty in Long-Term Budget Simulations

Budget simulations, particularly those that look out several decades into the future, are subject to substantial uncertainty about future changes in economic, demographic, and other factors that affect the federal budget. Future policy changes can also cause actual outcomes to diverge from budget simulations in any given year. GAO illustrates some of this uncertainty by running two sets of simulations—a Baseline Extended and an Alternative simulation—showing the effects of different policy assumptions on the long-term outlook.

GAO also conducts sensitivity analyses showing how its simulations would change if four key factors are higher or lower than assumed:

Excess health care cost growth. Historically, health care costs have grown significantly faster than GDP. While that growth has slowed in recent years, it is unclear how long this trend will continue. Health care cost growth several decades into the future is even more uncertain. Given that health care spending is one of the key drivers of the long-term fiscal outlook, future growth of health care costs significantly affects the federal government’s long-term fiscal outlook.

Interest rates. Interest on debt held by the public will be a significant driver of growth in federal debt in the future. While interest rates are currently at historic lows, CBO and the Trustees project they will rise significantly in the future, causing interest payments on federal debt as a percentage of GDP to rise.

Discretionary spending. Caps on discretionary spending enacted in the Budget Control Act of 2011 and revised by subsequent legislation would bring discretionary spending as a share of GDP to historic lows by 2021. It is uncertain whether Congress and the President will make adjustments to these caps in the near term, as they did in the Bipartisan Budget Act of 2013, which modified discretionary appropriations limits for fiscal years 2014 and 2015. The outlook for discretionary spending is even more uncertain over the long term.

Revenue. Revenue as a percentage of GDP can vary for a number of reasons including changes in tax policy and the economy. For example, in the past 5 years, Congress and the President have enacted changes in rates for high-income taxpayers, enacted a new tax on certain employment-based health insurance plans with high premiums, and temporarily extended dozens of tax provisions that would otherwise expire under current law—all of which affected the federal government’s fiscal outlook. It is impossible to know what policy changes will be enacted in the future. At the same time, revenues can rise and fall with changes in the economy. Revenue fell to its lowest level as a share of GDP in the past 50 years in 2009 after the recession, but, as the economy has recovered, it has recently risen to slightly above the 50-year historical average.

The ability of policymakers to control or influence these factors varies. For example, while Congress has direct control over discretionary spending through the annual budget process, interest rates are determined largely through economic factors and monetary policy.

In each of GAO’s sensitivity analyses, the federal budget path continues to be unsustainable over the long term. This provides further support that, without policy changes, there continues to be an imbalance between revenue and spending over the long term.

Major Health and Retirement Programs

The Baseline Extended simulation follows the Social Security and Medicare Trustees’ (Trustees) 2014 intermediate projections for Social Security and current law projections for Medicare, and Congressional Budget Office's (CBO) July 2014 long-term projections for Medicaid adjusted to reflect excess cost growth consistent with the Trustees' assumptions.

In the Alternative simulation, Medicare spending is based on the Centers for Medicare & Medicaid Services Office of the Actuary's (CMS Actuary) alternative projections that assume reductions in Medicare physician rates do not occur as scheduled under current law, and that certain cost-containment mechanisms intended to slow the growth of health care costs are not sustained over the long term.

GAO also runs simulations using CBO's long-term projections for Social Security and the major health entitlements. The results are consistent with GAO's simulations based largely on the Trustees' projections.

Discretionary Spending and Revenue

The Baseline Extended simulation follows CBO's January 2015 baseline for the first 10 years, which generally reflects current law. The baseline assumes that tax provisions that have expired, such as the research and experimentation tax credit, or are scheduled to expire, such as the expansion of the earned income tax credit will not be extended. The baseline also reflects the discretionary spending caps in effect through 2021 under current law and assumes discretionary spending grows with inflation from 2022 to 2025. The baseline also reflects the sequestration for certain direct spending (often referred to as mandatory spending) programs through fiscal year 2024 as scheduled under current law. After 2025, revenue and spending other than interest on the debt and large entitlement programs (Social Security, Medicare, and Medicaid) are held constant as a share of Gross Domestic Product (GDP). Over the long term, revenue as a share of GDP is higher and discretionary spending lower than historical averages.

In the Alternative simulation, expired or expiring tax provisions, such as the research and experimentation tax credit, are extended to 2025, and revenue is held constant as a share of GDP thereafter. Discretionary spending reflects the caps established by the BCA and revised by subsequent legislation through 2021, but not the downward adjustments required by the automatic enforcement procedures. After 2021, discretionary spending gradually rises to its 20-year historical average.

Effects of Recent Legislation

GAO’s 2015 simulations reflect several laws enacted since the last update that affect spending and revenue in CBO’s January 2015 baseline projections. These include:

legislation amending the Balanced Budget and Emergency Deficit Control Act of 1985 to extend sequestration of direct spending until 2024;

the Tax Increase Prevention Act of 2014,which retroactively extended about 50 expiring tax provisions for 1 year through 2014, resulting in an overall decrease in revenue over the next 10 years; and

the Veterans Access, Choice, and Accountability Act of 2014, which increased spending to improve veterans’ access to health care.

When CBO prepared its January 2015 baseline, physician payment rates were scheduled to be reduced by 21 percent in 2015 and smaller amounts in subsequent years under the sustainable growth rate (SGR) system. Subsequently, Congress has considered legislation that would repeal the SGR system. Unless offset by spending reductions or tax increases of equal size, such legislation would increase spending in GAO’s Baseline Extended simulation. GAO will incorporate the effects of any legislation affecting the SGR system in future updates.

Economic Assumptions

Real GDP growth follows CBO's January 2015 baseline for the first 10 years and thereafter averages 2.1 percent based on the intermediate assumptions of the 2014 Trustees reports. The interest rate on debt held by the public is equal to the rate implied by CBO's January 2015 net interest payments through 2025. Thereafter, the interest rate gradually increases to 4.7 percent, consistent with CBO's July 2014 long-term projection.

GDP is held constant across simulations and does not respond to changes in fiscal policy. Also, the implied interest rate on debt held by the public in GAO's simulations is held constant over the long term even when deficits climb. With large budget deficits, there could be a rise in the rate of interest and a more rapid increase in federal interest payments than GAO's simulations display.

Downloadable Data for the Baseline Extended and Alternative Simulations

File Name

BASELINE EXTENDED: Trustees' assumptions for Social Security and Medicare

Americans expect a range of services and benefits from government for many reasons. For example, they expect that when they retire, the government will keep its commitment to provide them with Social Security and Medicare benefits. Similarly, Americans may expect that when natural disasters strike, the government will provide funding for emergency response and long-term recovery as it has in the past. In budgeting, such expectations are referred to as fiscal exposures—responsibilities, programs, and activities that may legally commit or create these expectations for future federal spending based on current policy, past practices, or other factors. The magnitude of this future spending is difficult to quantify and is not fully reflected in the budget. Nonetheless, fiscal exposures are significant, pervasive and pose a high risk to the American taxpayer.

Fiscal exposures fall along a spectrum of the government's legal commitment. In addressing a fiscal exposure, it is important to consider the source of the exposure. Fiscal exposures can be organized by five sources of risk: demographics and health care, economic downturns, environment and disasters, government operations, and security. These categories are not mutually exclusive and are not comprehensive of the government’s full range of fiscal exposures.